Sean O'Grady: What difference will the currency crunch make?

Wednesday 9 April 2008 23:00 BST

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Isn't the euro meant to be a "toilet currency"?

This was the colourful judgement of one unnamed foreign-exchange trader when the European single currency was launched in 1999, a phrase seized upon in Eurosceptic circles. The euro was dismissed as a "synthetic" currency that wouldn't be able to withstand covering economies as diverse as, say, Ireland and Italy. The sacrifice of the deutschmark was felt keenly: the euro was thought an unworthy successor to such a strong, low-inflation currency. The euro started weak. At its birth, 4 January 1999, it was worth about 71p. It reached a nadir of 57p on 3 May 2000. But two years later it was back to its inaugural value. It has risen by 15 per cent in the past six months, to stand at 80p now.

Is the euro doing well because the dollar is doing badly?

Partly. The dollar is losing its lustre, as is sterling, and for similar reasons: the US is tipped by the IMF to go into recession and its financial system is in crisis, thanks to the credit crunch and a housing slump. Such problems have left the US currency in freefall, and no one wants to be invested in something losing value. Hence the boom in gold – and a shift into the euro.

Is a strong euro good or bad for the UK economy?

On the whole, good. A strong euro means that imports from the eurozone are relatively expensive, here and in third party markets such as the US. That is good news for British manufacturers and exporters. The UK's manufacturing sector has been one of the few bright spots in an otherwise bleak economic landscape. Although the economy's relative competitive advantage in financial services, and especially those activities concentrated in the City of London, is a long-term strength, the fact that car factories in Oxford, Sunderland and Swindon are exporting record numbers is helping to keep the economy afloat and jobs secure. On the other hand, a relatively weak pound has made it more difficult for us to deal with the soaring world price of energy and food. Having replaced sterling as the reserve currency of the world after the Second World War, the greenback is being usurped by a currency backed by an even bigger economic area, the eurozone, and one with a superior trading record. The vast US trade deficit with China isn't helping.

Alan Greenspan, the former chairman of the US Federal Reserve, said recently that it was "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency". Even the mild diversification of the trillions of dollars held by investors into euros has had a dramatic effect on the value of both.

Can the £1 euro be far away?

Maybe. The markets aren't completely happy with the eurozone – it has an unhappy combination of higher inflation and slower growth than the UK, for example, but parity could still happen this year. The Bank of England is expected to cut interest rates more rapidly than the European Central Bank. So, for example, while no move is anticipated from the ECB on rates today, there's expectation of a cut in rates by the Bank of England. European interest rates, at 4 per cent, are lower than UK ones, at 5.25 per cent, but the trend suggests a reversal. Investors are moving into the currency with the prospect of higher yields.

So should we have joined the euro?

The worst fears about the euro haven't come to pass and it is popular with citizens and businesses. It seems a better bet than the dollar, and our interest rates probably wouldn't be so different. It would help attract foreign investment.